Spooky Stuff: FCA Trolls Win Big in the Third Circuit
In today’s post-Halloween blog, we take a look at a case out of the Third Circuit that may have sent a shiver down the spine of any potential FCA defendant. This non-intervened reverse false claim case originating from the Eastern District of Pennsylvania previously had been dismissed with prejudice by the District Court under Federal Rule of Civil Procedure 12(b)(6). United States ex rel. Customs Fraud Investigations, LLC v. Victaulic Co., No. 15-2169, 2016 WL 5799660 (3d Cir. Oct. 5, 2016). Last month, however, the Third Circuit brought the case back, giving the relator's case a potentially promising afterlife.
The case centers around an allegation that the defendant (“Victaulic”) knowingly failed to disclose to U.S. officials that its imported pipe fittings were unmarked or improperly marked despite an affirmative obligation to do so under U.S. tariff laws. The
relator (“CFI”) alleges that by withholding this information, Victaulic avoided its obligation to pay a “marking duty” to the government. The Third Circuit held that failure to pay marking duties could properly give rise to a reverse FCA claim, based on the text of the statute as amended by FERA and the accompanying Senate reports. Id. at *7-8. What follows this textually-based rationale, however, is a much eerier analysis of the heightened Rule 9(b) standard of particularity.
Victaulic relator, CFI, is a corporate entity that was created by a
group of pipe-fitting industry professionals for the sole purpose of pursuing
the FCA claims against Victaulic, much like a patent troll seeking to enforce patents to which it has no real-world connection. In fact, not a single member of CFI is a former employee of Victaulic. Id. at *1. This is notable because as
made up of outsiders, CFI is not privy to the typical “insider” information that supplies the details of most qui tam FCA actions. Relators that are not “insiders” are not unknown in FCA litigation. See, e.g., United States ex rel. Kreindler & Kreindler v. United Techs. Corp., 985 F.2d 1148 (2d Cir. 1993) (law firm relator); United States ex rel. Doe v. John Doe Corp., 960 F.2d 318 (2d Cir. 1992) (lawyer relator); United States ex rel. Taxpayers Against Fraud v. Gen. Elec. Co., 41 F.3d 1032 (6th Cir. 1994) (special-interest group relator). Such relators, however, face a steep curve in developing sufficient evidence to establish a plausible FCA claim under Rule 9(b).
its dearth of actual knowledge of Victaulic’s imports, CFI relied instead on a self-crafted market survey to develop its claims. First, CFI reviewed shipping manifests to estimate that pipe fittings imported from China and Poland accounted for between 54% and 91% of Victaulic’s annual sales between 2010 and 2012. Based on this information, CFI alleges that “Made in China” or “Made in Poland” markings should appear on between 54% and 91% of all Victaulic pipe fittings for sale in the United States. In order to test this expectation for the U.S. market, CFI
next examined eBay postings for Victaulic pipe fittings. Based on its review of 221 postings for Victaulic pipe fittings and a small number of purchases from those postings (out of the tens of millions of pounds of pipes CFI alleges were sold each year), CFI estimated that about 75% of the Victaulic pipe fittings lacked country-of-origin markings, at least some of which, CFI concluded, must have been fraudulently unlabeled. Id. at *16-17. While the Third Circuit was “skeptical” of CFI’s “unusual” methods, a two judge majority court ultimately found that the study, combined with an expert report that vouched for the study’s process, was sufficient to satisfy Rule 9(b) at the motion to dismiss stage. Id. at *11-13. The court closed with a word of caution, noting its awareness of the “great expense and difficulty” associated with FCA discovery, and its expectation of “active involvement” by the District Court in the proceedings. Id. at *12-13.
The decision was made despite harsh criticism from the dissenting Judge Fuentes, who lambasted the relator’s statistical methods as “non-random observations gleaned from product advertisements,” “unsupported assumptions and numerical guesswork,” and asserted that relators have failed to introduce anything beyond “the mere suggestion of fraud.” Id. at *13. Judge Fuentes’ lengthy dissent (almost equal to the length of the majority opinion) takes on the eBay study step by step, pointing out the complete lack of particularized allegations (after all, even the eBay study could not support an inference that any particular pipe had originated in a foreign country, only that these particular pipes lacked a marking indicating as much). The closest relator came to a particularized allegation, according to Judge Fuentes, was a three-sentence section of the Amended Complaint in which an unnamed witness observed a packing list indicating one box of Victaulic pipes originated from Poland, and also that the pipe fittings themselves were unmarked. Id. at *22.
The majority’s holding is significant – and ominous – because it encourages other professional or outsider FCA relators to develop similar self-crafted market surveys or statistical “samplings” to compensate for their lack of direct insider knowledge of potential wrongdoing when bringing a qui tam FCA claim. And while a scathing dissent may bring some level of catharsis to a prospective defendant, the majority opinion does little to ward off the specter of professional relators.